Episode D.005 New Models of Compensation or Pay4Performance

New Models of Compensation or Pay4Performance
This is our last broadcast of the week on people. We have been developing  “What Makes People People” and today it is in the context of compensation, specifically paying for performance.

Some Context Here is your primer on People and Money. Salary is a recruiting tool, benefits are a retention tool, and if you want performance - pay for it.
 
Let that sink in. How many times have you been unhappy with an employee that works at the same level after getting a pay raise? A salary increase has a momentary positive impact (a week or two depending on your pay period) and then is taken for granted. As for benefits, its impact is to create golden handcuffs making it difficult to leave. Neither of these have any real impact on performance.
 
After 3 decades of consulting to large firms and turning around smaller companies - here is my fundamental lesson on compensation - treat everybody like sales. I pay salespeople for closed deals what if I did the same thing for everybody else - paid them for doing the right thing?

My three lessons about compensation and performance:

1. Tie Incentives to Profit, Not Revenue
2. Tie Incentives to Contribution, Not for just Breathing, and
3. Everyone has a Piece of the Budget

The only true measure of business performance is profitability, not revenue. It doesn’t matter how much money flows in; it is all about what is left in the cigar box. If it is true about you as the owner why should it be different with anybody else. Tie all of your compensation to how people impacted the amount of money left in the bank.
 
Ready for another shock? All compensation systems work! You just don’t like the result. Why is that true? People will do what you pay them to do even achieving unacceptable results because it was designed badly. The chance for mistakes are lowered when pay is based on how people contribute to business success. Get this right and figuring how to reward them is easy.
 
Get everybody into the game, the great game of business. Most people work in environments where they are forced to bowl with a sheet over the lanes. Imagine the only feedback you receive is noise without knowing how many pins were knocked down or where? And where do you throw the second ball? Why are you the only person losing sleep at night because the company is not performing? Share the load.

Here are three Quick Tips for Tying Compensation to Profits.
The challenge is most small business owners don't understand which customers or products / services are generating the most profit. If this is true for you - start here:

1. Select Your Top Service Line (Most Revenue) and break it into steps;
2. Each step is given material and labor costs, figure out what each step is costing you;
3. Add a margin to each step. Given overhead costs, taxes, etc., it is hard to make any profit on margins below 30%. Start at 60% and see what happens. Another option is to ask “what if you had to buy that step from a competitor - what would they charge?”

You are still not sure this is the most profitable customer or product / service, but you have attacked the area of the greatest profit potential. Next step is to determine where the greatest contribution to the business can be made by position or step. This is the core of your compensation system:

1. First thing is to figure out how much to share. 5-10% is a good place to start and see what happens. It is better to pay less at the beginning and adjust up than taking it away.
2. Find the behaviors critical in each step to bonus. Wrap your head around the real goal - you want them to do more of the right things so they make more. What behavior will help your bottom line?
3. Make sure you measure it. If your current system doesn’t capture the information, find the easiest metric and add it to your measurement puzzle.

​There are some issues about how to measure I will leave for later Shows. The last issue for creating a Pay4Performance system is linking what they do to what the company needs - giving them a piece of the budget:

1. Business Objectives - if you have none it is time to make this happen. People need line of sight between what they do and how they are paid. You are not running a charity. Most for-profit businesses follow this simple formula F=C+P+T. Finance ($$) equals Customers buying stuff you Processed and built by Talent.
2. Individual Best Season - this is less about competing against a team member or someone in the next office, it is all about competing with yourself. Challenge people to raise their game (the behaviors you identified for bonus) so they can grow their checks.
3. Make them responsible for their part of the budget. If an Installation Foreman is running a crew that cost $3,000 in materials and $4,000 in labor - have them own it. If the Crew Leader can deliver the estimated cost of $7,000 at $6,500 - are you up for giving them a dime on the dollar?